Are ARMs making a comeback?

Hybrid mortgages offer a fixed rate for a certain period of time before it adjusts, typically moving up. For example, a 5/1 adjustable-rate hybrid would mean the rate is fixed for the first five years of the loan and then will adjust every year until the loan is paid off.

Unlike adjustables of the past, today’s ARMs require consumers to prove they can afford their mortgage payments. Applicants must provide an extensive list of paperwork, including pay stubs, tax records and credit reports.

What to know

Adjustable-rate mortgages have a lot of moving parts, so it’s important to understand how they work. Consumers should know or ask about:

• What the different loan types are. Consumers, for instance, can pick from a variety of hybrid adjustables, including 3/1s and 5/1s to 7/1s and 10/1s. The first digit denotes the duration of the fixed rate timeframe and the second digit denotes the how often the rate will adjust after the initial period.

• How long they intend on staying at the home they’re buying. For people planning on remaining in their homes for a short period a time, a longer-term fixed mortgage such as a 30-year may not make sense.

• Adjustable-rate mortgages are often used in the jumbo-loan market, where rates tend to be higher. An ARM can save consumers thousands of dollars.

• What goes into determining rates. They’re based on adding the margin, which come from lenders, and the index, which varies by mortgage provider. Companies can base their rates on indexes such as the Treasury rate and London Interbank Offered Rate, or Libor. Their historical performances are publicly available. Ask lenders which they use.

• When and how their loans will adjust. Mortgage documents should clearly state how long the rates will be fixed and when they’ll change. Paperwork also must disclose rate caps, which limit how high interest rates can adjust periodically and over the life of the loan.

• Whether current income will cover the potential maximum-payment amount, which must be disclosed by lenders. ARMs may offer savings in the beginning but any changes to the index can mean higher rates and, in turn, higher monthly payments.

The future of ARMs

It’s unlikely that riskier adjustable-rate products will make a comeback, in light of the federal government’s push for more mortgage regulation.

One future rule would prevent mortgage lenders from using lower introductory rates to qualify borrowers. Lenders would instead have to use a higher fully-indexed rate, which could mean less people would get adjustables.

Such changes, brought on by the Dodd-Frank Act, are expected to go into effect next year.

The result could be a mortgage market that offers fewer and simpler mortgage products. The plus: Consumers may be less likely to get into financial trouble. The downside: less consumer choice, Lea said.

For now, since adjustable rates are lower than fixed ones, some mortgage professionals like Susanne Livingston, co-owner of Residential Whole Mortgage in Carmel Valley, are recommending to certain clients to get the longest-term adjustable-rate possible with a product such as a 10/1. That way, consumers can lock in lower rates for a longer period of time.

“Adjustable rates can prove to be very useful when they’re understood and when consumers are educated,” Livingston said.